Manager interview: Capturing the equity risk premium

Biography

Hartwig Kos is co-head of multi-asset and vice chief investment officer at SYZ Asset Management. Based in London, he manages the euro-denominated Oyster Multi-Asset Diversified fund. He joined the firm in 2015 and deals in global multi-assets using a top-down approach. Prior to this, he worked at Baring Asset Management from 2005. Kos graduated from the University of Basel and Cass Business School with qualifications in economics and finance. Outside of work he lists the theatre and skiing among his interests.

Your fund is benchmark agnostic. How, then, should we judge its performance?

We try to deliver equity-like returns with less than equity risk. We believe investors want equity-like returns over the long term, but cannot stomach the volatility of equity markets. Over the course of an economic cycle, we aim to capture this equity risk premium. Equity risk premium is a very abstract concept, so we say we want to achieve 5% to 10% return per annum over an economic cycle, with around 5% to 10% of volatility. Another objective of the fund is to deliver positive returns on a rolling three-year basis.

You describe one of your asset classes as ‘special opportunities’. What does this refer to?

For us, special opportunities is what other people would call alternatives. We call it special opportunities because the notion of alternatives has a sort of diversifying character to it. We buy special opportunities because we believe we can derive different alpha from these opportunities, not just for the purpose of hedging. Special opportunities we hold are areas such as litigation finance and commercial aircraft leasing. In our view, gold and Reits would be considered as special opportunities.

These special opportunities are not there to reduce the risk of the portfolio. We want them in the portfolio because they give access to different idiosyncratic types of alpha.

Your fund is priced in and largely hedged into euros. Is this a problem for prospective UK investors, given the euro’s current strength?

I don’t think so. Yes, the euro has been extremely strong in the last six to eight months. But you must bear in mind that the uncertainties that we have seen with regards to Brexit will continue, or are most likely to continue, to put pressure on sterling.

I wouldn’t be surprised if the euro continues to be quite solid and strong relative to sterling. For the purposes of a UK investor, having some euro assets is not such a bad thing.

In a recent outlook piece you pinpointed a link between the strength of the euro and a disappointing European corporate earnings season.

European equities, especially in the northern European block, are very much driven by exporters. When the euro is soft, these exporters do well. When the euro strengthens, they are under pressure.

The recent strength of the euro has clearly held back European equities. People became worried about the outlook for the euro: we are at $1.20 now, but might it go to $1.25 or $1.30? So people were more neutral on European equities than they previously had been. If we see a persistent strength in the euro beyond today’s level, we might need to worry somewhat.

Our view is we have seen a strong rally in the euro, we have hit this magical level of $1.20 and we might see a slight pause in the appreciation of the euro for the time being.

Why is 25% of your fund in emerging markets bonds?

Because that’s one of the few bond markets where there is value left. Let me take a step back. 25% of our fund is invested in emerging market hard currency bonds; these are bonds denominated in foreign currencies. For us, this is a proxy for investment grade credit and to the credit allocation that a lot of multi-asset funds have in general.

European and US credit are particularly expensive. We have been cutting that asset class out of the portfolio systematically since the beginning of the year and have used emerging market hard currency bonds as a substitute. In valuation terms they are not as attractive as they were in 2016, but they are still at OK levels. A lot of them are priced off the dollar and off US assets. The weakness in the dollar has meant they have gone through a relatively mild, positive market environment. For us, this is a really good substitute asset class.

You also have to bear in mind it is much more liquid than US or European investment-grade credit. There has been so much investment in those areas that the market has really started to quieten down and dry out. Some of these names are not at liquidity levels at which you would be comfortable committing 25% of the portfolio.

Is this perhaps because people are concerned that QE won’t continue?

Potentially yes.

Your fund ranks top of the Mixed Assets Flexible Euro sector over five years, but your volatility is relatively high. Why is this?

I think the fact the fund is more directional than absolute return funds, and bond markets are not the same diversifiers as they were, has led to our volatility of 6.5%. But I don’t think this is much higher than most of the peer group.

Has the Trump trade reversed and what does that mean for your fund?

We are now at the point where people don’t believe in the Trump trade anymore, which opens up an opportunity. I think the hurdle rate is extremely low. So, the market might potentially be surprised by a small win that Trump could achieve in terms of tax reform or other things.

What opportunities are you currently seeing?

Overall I would say European equities have, since mid-May, underperformed relative to other assets in local terms. This is basically because of the strength of the euro. I think the euro might not see such strong appreciation in the next few months, so holding some European assets would potentially be quite an interesting opportunity.

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